week 5 - intertemporal choice

Question 1

what is the standard model of intertemporal choice

Answer 1

max (c1) U(c1, w - c1)

Question 2

what is the interpretation of the components in the standard model of intertemporal choice

Answer 2

• w is initial wealth
• wealth is divided into consuming now and in the future
• the model resembles a two commodity model
• w2 = c2
• future utility is discounted

Question 3

• Often economists assume a preference to consume now rather than in the future.
• Future utility is discounted

How is this written in utility

Answer 3

U(c1, c2) = u(c1) + δu(c2)

where 0 < δ < 1 is a discount factor and u(c) is instantaneous utility

Question 4

what does a larger δ indicate

Answer 4

flatter indifference curve, more patience

Question 5

how can the indifference curve of the standard model of inter-temporal choice be written

Answer 5

dc2/dc1 = -u’(c1)/δu’(c2)

Question 6

what is mispredicting utility also known as

Answer 6

• projection bias
• people believe that they will value options in the future as they are valuing them today

Question 7

what does u˜(c,s | s′) represent

Answer 7

the predicted utility of consumption under state s when the decision maker makes the prediction while in state s’

Question 8

when does one display projection bias

Answer 8

u˜(c,s | s′) = (1 − α)u(c,s) + αu (c,s’)

where 0 < α <= 1

Question 9

what is the model of projection bias under time inconsistent preferences

Answer 9

max c1 u (c1,s′) + δu˜(w − c1,s | s′) = u (c1,s′) + δ [(1 − α)u (w − c1,s) + αu (w − c1,s′)]

i.e. predicting consumption conditional on state s’, if there is no prediction bias α = 0

Question 10

graph for mispredicting utility

Answer 10

lecture 5, slide 21

point B = no projection bias
point A = projection bias

Question 11

how can we model addiction

Answer 11

• a two period and two good model, coffee and food
• utility could be lower the higher the coffee consumption in the last period
• marginal utility of coffee depends on the last period
• marginal consumption of food is constant in this model
• diminishing marginal utility in current consumption
• there are two periods and before the first period no coffee is consumed
• the discount factor δ, and prices for both food and coffee are equal to 1

Question 12

what is the maximisation problem of the addiction model

Question 13

what does the exponential discounting model

Answer 13

• can be used to model procrastination
• preference to consume now rather than in the future
• 0 < δ < 1, higher δ = more patience
• procrastination means that preferences are inconsistent over time

Question 14

why is a constant δ in a fully additive model attractive

Answer 14

if its not constant, can lead to time inconsistent preferences

Question 15

if α = 1 in the model of projection bias what can we deduce

Answer 15

that the utility in state s is predicted to be identical to current state s’ utility

Question 16

what is sachett and torrance’s (1978) example of mispredicting utility

Answer 16

they looked at those with kidney disease and the individuals who were currently undergoing treated mispredicted (overpredicted) the effect that the disease will actually have on their life

Question 17

what is simonsohn’s (2010) example of mispredicting utility

Answer 17

they found that when people visited prestigious universitys on days with bad weather, people were more likely to apply to that university

Question 18

what is the economic explanation of simonsohn’s (2010) example of mispredicting utility

Answer 18

• rainy days: increases the utility of studying at both prestigious and party uni, but more at prestigious
• sunny days: increases the utility of recreational activities at both unis but more for party uni
• i.e. if they visit on a sunny day, people mispredict that it will be sunny most days when they actually attend, vice versa

Question 19

what is δ sometimes referred to as

Answer 19

a measure of patience

Question 20

what do time inconsistent preferences lead to

Answer 20

lower lifetime utility

Question 21

over a short period of time what should δ equal

Answer 21

close to 1, choices over a short period of time should be consistent, a choice from today to tomorrow should not differ too much

Question 22

if preferences are not consistent what does this mean for the value of δ

Answer 22

δ is not constant

Question 23

what is the implication of procrastination

Answer 23

preferences are inconsistent over time

Question 24

what is a property of the fully additive model with exponential discounting

Answer 24

it is stationary, because it assumes a constant discount rate

Question 25

what is the solution to capture procrastination in a model

Answer 25

quasi-hyperbolic discounting